The executive stock options indexed to the market are useful as a compensation scheme
in that the indexed options protect shareholders from rewarding executives excessively
during market upturns. Despite the usefulness of indexed options, most of the large ¯rms
in the US have not granted an indexed option. According to academic researches on
executive stock options, the probability of expiring in the money is too small to offer risk-
averse executives incentives to work more efficiently. This paper develops a new indexed
option model and explores the incentive effects. While there is a similar indexation feature
between the existing indexed options and the new one, a different payoff structure has a
signi¯cant in°uence on option values and incentive effects. We show that the new indexed
option has the higher probabilities of expiring in the money and increases incentive effects
relative to the existing one.